Managers keep faith with UK stocks

Investors with a long-term view remain optimistic on the prospects for British equities – despite last week’s stockmarket turmoil and Mervyn King’s warning of more “choppy waters”.

British equities took a battering at the start of last week as global stockmarkets reacted to fears over the American economy. The FTSE 100 index fell by 5.5% on Monday, finishing the day more than 300 points lower, on 5,578.2. While the index has recorded far bigger single-day percentage drops in the past – the 12% fall on October 20, 1987 for example – many investors were surprised by the scale of the slide.

Other markets followed suit and some, including the French CAC 40 and German DAX indices, fell more sharply, by about 7%. On Tuesday the FTSE 100 continued to fall, but markets reacted positively to the Federal Reserve’s three-quarter point cut in American interest rates, to 3.5%.

Following the announcement, the FTSE 100 rallied strongly, finishing Tuesday up 2.9%, on 5,740.1 points. However, a speech later the same day by Mervyn King, the governor of the Bank of England, put a brake on the renewed sense of optimism. Speaking at a dinner hosted by the Institute of Directors South West and the Confederation of British Industry, King likened the outlook for the British economy to a seafaring voyage which will have to “navigate some distinctly choppy waters” in 2008.

King highlighted the threat of two economic “winds” this year. The first, he said, was the onset of tighter credit conditions stemming from increased defaults in America’s subprime mortgage market. This would continue to have a knock-on effect on British consumer spending in 2008, with a consequent slowdown in economic activity.

But despite this environment of lower growth, interest rates were unlikely to fall in the short term, he added, because of the inflationary pressures of higher energy and food prices, driven by rapid growth in Asia.

King’s concerns, and the revelation that only one member of the Bank’s Monetary Policy Committee voted for an interest rate cut in January, caused further turbulence for FTSE 100 stocks on Wednesday and by the close of play, the index was down by more than 130 points.

However, not all investors are pessimistic on the outlook for British equities and some used last week’s falls as a buying opportunity. Greg Bennett, manager of Marlborough’s UK Large Cap Growth and UK Equity Income funds, topped up his holdings in financials, industrials and commodities.

“There is no doubt that the economic outlook has worsened and the Fed’s decision may be delaying the inevitable,” says Bennett. “There are problems in terms of the credit that has been extended to people. But it is not looking calamitous and some stocks are more than compensating for the additional risk. People have sold indiscriminately.”

The Adviser Fund Index (AFI) panellists also appear to be maintaining their long-term perspective. Sam Sibley, an investment manager at Beckett Asset Management, says: “We invest with a five-year time-frame and it is dangerous to be short-term in your outlook. It is tempting to make a knee-jerk reaction but we will look back in a few years and this will just be a blip. We still have a core weighting in the UK.”

Within her British allocation, Sibley has reduced her exposure to mid-caps and is focusing on large cap funds and earnings visibility.

Mick Gilligan, director of fund research at Killik, is increasing his exposure to “experienced” British equity managers, such as Invesco Perpetual’s Neil Woodford and Axa Framlington’s Nigel Thomas. Despite his preference for Woodford’s £6.7 billion Income and £9.5 billion High Income portfolios, Gilligan has moved away from equity income funds because of their exposure to financials. But he adds that there are opportunities in the sector and he has increased his holding in Jupiter’s specialist Financial Opportunities fund.

While Sibley declines to forecast where the stockmarkets will finish the year, she expects a “good second half” for British equities, with the markets responding positively to lower interest rates. In a report published last week, Lombard Street Research forecast a quarter-point cut in February. Lombard, an independent provider of macroeconomic research, predicts three further cuts, reducing the rate to 4.5% by the end of the year.

Whatever the future for British stocks this year, they continue to be the most important influence on the performance of the AFI. The Aggressive, Balanced and Cautious indices have weightings of 39%, 40% and 36% respectively to domestic equities.

The Aggressive and Balanced allocations fell by small amounts during last November’s rebalancing.